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Global financial system still vulnerable

17 September 2018

Ten years on from the collapse of the Lehman Brothers, Jens Hagendorff, professor of finance at the University of Edinburgh Business School,  warns that the global financial system remains vulnerable. 

Hagendorff cites increasing bond spreads in Italy, jitters in emerging markets and the low market valuations of European banks as evidence of investors continuing to feel nervous.

He says: “Equity capital is the most effective absorber of bank losses. Since the Lehman collapse and the crisis that followed, many banks have increased their equity capital. However, the discussion far too often focuses on increases in capital. The problem with this is that even sizeable increases in equity are not sufficient if the level of equity pre-crisis was painfully low.

“Today the level of equity held by many of Europe’s largest banks remains low. The spark for the next Lehman style crisis is likely to come from Europe. In Italy, in particular, the doom loop between banks and their government continues. Even a small haircut on those bonds would cause Italian banks such as Unicredit to become insolvent. What would follow will enter the history books like the Lehman bankruptcy.”

Hagendorff says the goal of the financial markets is not to design a system whereby banks never fail as that would be impossible to achieve, but to put in a place a system where banks may fail without endangering the stability of the global financial system.

“The Lehman bankruptcy has taught us how not to fail a bank. Global regulators are still working on the rest,” he added.

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